Duke Energy Corporation (DUK) Q1 2012 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Duke Energy First Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Bill Currens, Managing Director of Investor Relations. Please go ahead, sir.

Thank you, Sandy. Good morning, everyone, and welcome to Duke Energy's First Quarter 2012 Earnings Review and Business Update. Leading our discussion today are Jim Rogers, Chairman, President and Chief Executive Officer; and Lynn Good, Group Executive and Chief Financial Officer. Jim and Lynn will review our first quarter results and provide an update on key issues. After their prepared remarks, we'll take your questions. Today's discussion will include forward-looking information and the use of non-GAAP financial measures. You should refer to the information in our 2011 10-K and other SEC filings concerning factors that could cause future results to differ from this forward-looking information. A reconciliation of non-GAAP financial measures can be found on our website and in today's materials. Note that the appendix to the presentation materials includes additional disclosures to help you analyze the company's performance. Now I'll turn the call over to Jim Rogers.

Thank you, Bill. Good morning, everyone, and thank you all for joining us today. We appreciate your interest and investment in Duke Energy. Today, we will review our quarterly earnings results, provide an update on economic activity and customer load growth trends, as well as summarize what we are experiencing with coal-to-gas switching. We will also review the status of our combination with Progress Energy and discuss the settlement agreement we announced earlier this week with respect to the Edwardsport project in Indiana. This settlement agreement resolves uncertainty regarding the cost recovery of this important investment. I will review the terms of this settlement later in my remarks, but let me begin with an overview of the quarter. Today, we announced first quarter 2012 adjusted diluted earnings per share of $0.38. That compares to $0.39 in the first quarter of 2011. Reported earnings for the quarter were $0.22 as compared to $0.38 in the prior year. Current quarter reported results reflect $0.20 of charges related to the settlement agreement on the Edwardsport IGCC project in Indiana. This charge has been treated as a special item for the quarter. Consequently, it has been excluded from our adjusted diluted earnings per share. The quarter was characterized by unusually mild weather across all of our service territories. In fact, this past winter was the fourth warmest winter season on record for the entire U.S. I am pleased with our employees' efforts to effectively manage costs during the quarter. This helped offset some of the impact from the weather. We also benefited from increases in customer prices in the Carolinas as a result of our rate case request last year. In our commercial businesses, international operations continue to deliver strong results, mitigating the reduced earnings we expected from our new ESP agreement in Ohio. In addition to cost control, our operational performance during the quarter was impressive. The regulated nuclear fleet delivered a capacity factor of 99.7%. Meanwhile, our nonregulated gas fleet in the Midwest continued to operate at record-generating levels, benefiting from low gas prices. I am pleased with where we stand at the end of the first quarter. While we cannot control the weather, I commend our employees for focusing on what we can control, specifically our fleet and grid performance, as well as our expenses. Based upon our first quarter results, we are on track to achieve our 2012 adjusted diluted EPS guided range of $1.40 to $1.45. Now I'll turn it over to Lynn for a more in-depth discussion of our financial performance for the quarter.

Thank you, Jim. Slide 6 outlines the significant adjusted earnings drivers for each of our business segments for the quarter. As a reminder, we are now evaluating our business performance on the basis of segment income, rather than on our previous segment EBIT basis. As a result, earnings for each segment include interest and income tax expense. In addition, corporate governance costs, which were previously reflected in the category labeled other, are now allocated to each segment. First, let's review earnings for our regulated utilities, U.S. Franchised Electric and Gas. Quarterly adjusted segment income was relatively flat with the prior year quarter. Revised customer rates in the Carolinas and lower operation and maintenance expense helped to offset the impact of unfavorable weather. Let me give you some perspective on the mild weather, which affected earnings per share by about $0.04. In the Carolinas, we had the lowest level of heating degree days on record for the first quarter. Heating degree days were below normal by around 25% in the Carolinas and 28% in the Midwest. We were able to offset about $0.01 per share of the weather impact with reductions in our O&M costs during the quarter. Due to the unfavorable weather and the low natural gas price environment, we are generating fewer megawatt hours from our coal plants. We've examined our operations for opportunities to reduce cost. From a labor perspective, we have displaced contractors, reduced overtime and have not filled open positions. Additionally, we will defer certain scheduled outages since the plants are not running at the levels we originally anticipated. Assuming normal weather and storm activity, we expect our 2012 O&M to be down about 2% from 2011 as a result of the actions identified in the first quarter. We will maintain our focus on costs while…

Thanks, Lynn. Let me start with our pending merger with Progress. On March 26, Duke and Progress jointly filed a revised mitigation plan with the FERC to address their market power concerns. This slide summarizes the components of our revised mitigation plan. The filing features both interim and permanent mitigation components. The permanent mitigation solution involves the building and upgrading of transmission and an estimated cost of about $110 million. The transmission projects are designed to significantly increase power import capabilities and enhance competitive power supply options in the Progress and Duke Carolinas service territories. The proposal also features a 2- to 3-year interim mitigation plan with firm power purchase agreements already signed with 3 third parties. The agreements will be in place from the date the merger closes until the transmission projects are operational, at which time the interim mitigation will terminate. The costs of this interim mitigation, which we're able to currently estimate, are included on this slide. Our regulatory and legal teams have spent considerable effort investigating solutions to address FERC's concerns about market power in the Carolinas. FERC's common period on our mitigation plan ended last week, and we responded to intervenor comments earlier this week. We believe that our revised mitigation plan addresses the FERC's concerns and that the protests to the plan are without merit. We've requested that FERC issue orders approving the mitigation plan, the joint dispatch agreement and the joint open access transmission tariff no later than June 8. After satisfactory FERC approval, we will continue to seek final merger-related approvals from the North Carolina and South Carolina commissions. Over the past several weeks, we have had constructive discussions with the North Carolina public staff. These discussions have centered on how the cost of the proposed FERC mitigation plan will be handled…

[Operator Instructions] And we'll take our first question from Jonathan Arnold with Deutsche Bank.

Jim, first, on the merger, I just noticed that you mentioned that you've restarted the integration process. So I guess my question is, does that mean it stopped? And when was that? And what changed? And can you just provide some color on what you're referring to?

Sure. Let me ask Lynn to address that question, if I may.

Jonathan, at the time we received the FERC order in December, we really put pencils down a bit, finishing up what was going to be required for legal day 1 but really putting it on the shelf so that we could get focused on running Duke and Progress separately at the beginning of the year. We didn't have specific clarity on timing of the FERC filing and closing, et cetera. So we've been focused first few months of the year on the things you would expect us to be focused on, running the business well. And now we believe we're getting to the point where we should start brushing off the legal day 1 work and restarting integration so that we're prepared for a July 1 closing.

Okay. And then on the coal piles, could I ask -- can you give us any sense of where you are currently within this? You said you're above the 45- to 50-day range, but you're not at the 75 to 80. Where are you in that range? Do you think you'll get to the maximum? And is this any -- very similar to '09 or more dramatic?

Jonathan, we are at about 90% of the peak levels of 2009, so we're not quite to the point we experienced in 2009. And the teams are very focused on managing through this, taking all the steps we think are necessary, including off-site storage and other measures. So we're managing through it and believe we will be able to manage through it.

Moving on to Dan Eggers of Credit Suisse. Dan Eggers - Crédit Suisse AG, Research Division: Jim, there certainly seems like there's some momentum with the conversations you guys are having with the staffs in North Carolina and South Carolina. But can you just maybe mechanically or logistically walk through how a settlement would synchronize from the states with trying to get a FERC decision done and how they would marry together? Because obviously, they're kind of early stage or dependent upon the FERC decision, how that would all play out in June if things worked as you guys have them scheduled right now?

Absolutely. Dan, first, let me say that our aspiration is to get a decision from the FERC in early June. In the interim period, we're working with the public staff in North Carolina, as well as the consumer council in South Carolina, to reach settlement agreements that we can present to the state commissions for their approval. We've had detailed conversations with the public staff in North Carolina. Our discussions have focused on what is the appropriate treatment for the $110 million investment in transmission. It has been focused on some additional flexibility with respect to our guarantee of $650 million in the joint dispatch and fuel blending. It's also been focused on other items such as our sale of electricity during the interim period. So we are very close to reaching agreement with the public staff, have not reached agreement with other parties with respect to this in North Carolina. And so more to come there, and we hope to have a settlement soon. With respect to South Carolina, we're also working very closely with Dukes Scott and his team so that we can satisfy his requirements. And I think an important part of the relationship between North and South Carolina is that Dukes Scott negotiated early on a Most Favored Nation's Clause, which really allows them to track whatever agreement is reached between us and the public staff in North Carolina.

And so, Dan, maybe just to put those things together, the intent would then be to be in a position where the commissions could approve this settlement following FERC approval in that June time frame. Dan Eggers - Crédit Suisse AG, Research Division: So because the commissions wouldn't decide, basically, you'd have a -- this settlement which could then be adjusted if the FERC makes adjustments and then -- and bring it to them so they wouldn't actually have to revise what they had done because they wouldn't have made the decision.

That's a very good observation on your part. We are building in a provision in our settlement that we're working through now with the public staff for the possibility that the FERC will not fully embrace our proposal and will modify it in a way -- one way or another. And if that happens, then we have the capability to really reopen the agreement we have with the public staff and make any adjustments that are appropriate given the FERC's action. Dan Eggers - Crédit Suisse AG, Research Division: Okay. And I guess just one other question. You guys have talked on a merged basis of 4% to 6% earnings growth as the target without any equity. Are you still feeling comfortable with that at this point in time? And do you feel comfortable without the equity needs, given some of the loss of cash you guys have with the Edwardsport deal and some of the loss of cash that Progress put up in the Crystal River deal?

Dan, we are still targeting the 4% to 6%. We think the combined company has the fundamental growth drivers of investment and load synergies, of course, will be very important to drive that growth. We will be finalizing guidance as we near completion, restart integration, get a better sense of synergies, timing, et cetera, and be prepared to give you more specifics post closing.

Moving onto Hugh Wynne with Sanford Bernstein. Hugh Wynne - Sanford C. Bernstein & Co., LLC., Research Division: Question is on the -- primarily to Edwardsport and what, if anything, remains to be [indiscernible]. The -- you mentioned you're in the testing phase. Has the gasifier at Edwardsport -- hello, hello? [Technical Difficulty] Hugh Wynne - Sanford C. Bernstein & Co., LLC., Research Division: Hello? My question was, has the gasifier at Edwardsport been tested yet?

We were having trouble hearing you. Can you restate?

Mr. Wynne, are you still on the line? Sir, this is the operator. And Mr. Wynne has disconnected. We'll take our next question from Michael Lapides with Goldman Sachs.

One real quick thing. When I go back and look your guidance for -- that you provided at the end of the fourth quarter call or during the fourth quarter call. Look at the USF&G. You expected it to be up year-over-year about $0.12. Nowhere in there is there any bullet points for O&M cost reductions. And yet, based on the commentary and what I'm seeing in the abbreviated data at the back of your release, it seems like you've actually managed O&M down a bit in the first quarter. Can you comment on that? Can you comment on expectations for O&M for the rest of the year relative to last year, both at USF&G and maybe at Commercial Power?

And, Michael, let me respond on USFE&G. We actually came into the year assuming O&M would be flat, 2011 to 2012. And as a result of the weak weather that we experienced also, we are continuing to build in some flexibility for the possibility that load growth doesn't show up as strongly as we anticipated. We have taken some actions that now put us in a position to forecast that O&M will be down 2% year-over-year. This gives us some flexibility in FE&G as a result of the start to the year. So that's the way I would think about it. In commercial, a lot of the O&M in commercial can actually be tied to generation, specifically in Latin America. And so we look at that O&M a bit differently and really try to give you a sense of margin and other things that we see in those businesses.

Got it, okay. One other question just in terms of thinking about PJM coming up in the next couple of weeks, assuming the auction results are actually released in the next couple of weeks. When you guys look at the market just in general, do you still have the view that coal plants are needed at peak in PJM? And if so, is it entirely just scrubbed coal plants? or even -- does PJM still need some of the unscrubbed coal plants at the peak?

Michael, it's my judgment that in PJM, they still need all the scrubbed plants and some of the unscrubbed plants at peak period.

So when you think about market fundamentals or kind of what's normal or long term, either an unscrubbed coal plant, whether its energy or capacity, needs to set the clearing price or some other asset replacing that plant needs to.

I think that's right. I think, historically -- and let me see if I remember the -- I think it's about 85% on gas is on the margin in PJM. And I think that will continue to be the case, even though there's been a flip in gas prices and coal prices and a flip in the dispatch. Said another way, the gas units, particularly combined cycle units, are dispatching with the 7,000-plus heat rate before most coal plants or virtually all coal plants in the region.

Got it. Okay, Jim. Last question, just Commercial Power, really Duke Energy International, any change in your thoughts about the growth outlook, especially with kind of the next year sharing at National Methanol, kind of what the growth trajectory of this business is relative to your U.S. businesses?

Michael, I think we talked a little bit about growth on international as we put forward guidance. We think international is a very solid contributor to the company. It has growth prospects with the repricing of the contracted load in Brazil, and there's actually some information in the year-end package that might be helpful on that. We will also bring some new resources into the international business as we go forward. I think as you look at Commercial Power, growth is going to occur over a longer-term basis as we see capacity prices rise and, hopefully, a broader spread in energy.

Moving onto Brian Chin with Citi.

Jim, if the FERC says it needed another month to review this, and that sort of drags out the process into August, would you be willing to extend the merger agreement another couple of months?

Brian, I'm not going to speculate on what we'll do with respect to extending the time of July 8. We're going to wait until we get there and wait to see what orders we get from the FERC and from the commissions and address that issue at that time.

Moving once again to Hugh Wynne with Sanford Bernstein.

Hugh, I'm sorry. You dropped off somehow. Hugh Wynne - Sanford C. Bernstein & Co., LLC., Research Division: Hello? [Technical Difficulty]

Mr. Wynne has dropped again, sir. We'll move on to Andy Levi with Avon Capital.

Known you for a long time, so a very, very simple question for you just concerning the merger. I just want to make sure that you're still very committed and still very excited about this merger.

We are very committed to getting this merger across the goal line. This is the third time we've filed with the Federal Energy Regulatory Commission. We've reopened negotiations with both states in an effort to get this done. As the prior question from Brian was all about July 8, and in our judgment, there's adequate time for both the state and the FERC to act, so we can get this across the goal line. So I'm confident that we will. And if you had to put a probability on it, you'd say, more likely than not, we'll get it done.

And you're still excited about it, as you were when it was announced?

I don't know, at my age, if I'm excited about much. But...

Okay. Fair enough, Jim. You're still a young man. Come on.

Yes, yes, yes. But if you look at this transaction from a long-term perspective, this is -- positions us well for the future, and we wouldn't be continuing to work as hard as we've worked and our teams have worked if we didn't think this was the right thing going forward. So thank you.

The next question will come from Andy Bischof with MorningStar.

A question for you, I'm trying to get a grasp of the likelihood of an approval by the Indiana commission for Edwardsport. What discussions were had with the commission during Edwardsport? And how are their concerns taken into consideration?

Andy, as you might imagine, we didn't talk to the commission when we negotiated this settlement. We worked hard with the consumer council, who plays a very important role in the state, as well as the industrial group in Nucor. We had many negotiating sessions to get to that settlement. And I think what's important is, is by putting these parties together and presenting it to the commission, we're presenting to them a package that really allows them to address all the issues that have been raised in the proceeding and put this behind the commission, behind us and allow us to go forward to build what may be the last coal plant that will be built over maybe a decade or more, given the price of gas and given the new proposals from EPA with respect to carbon.

Great. So you're pretty comfortable that the commission will look favorably upon this agreement?

I'm hopeful because we've had a long history in Indiana, as well as other states, of reaching agreements with the parties and presenting settlements to the commission and having the commission approve them. And we hope that, that occurs here, and that's certainly our expectation.

Moving onto Jim von Riesemann with UBS.

Just 2 questions for you, if you don't mind. The first one is on Edwardsport, and I have the same question that Hugh was trying to ask because I could hear him. But could you just give us an update as to how the test firing is going on the Edwardsport facility?

So, Jim, I'll give it a try, and Danny Jamil is here to correct me when we get into maybe more detailed questions. But we have tested on gas firing of the turbines. We have scheduled tests for the gasifier within the next 6 to 8 weeks, and are moving through the start-up process in a very methodical way. We have operations teams on the ground, ensuring we have a smooth transition from construction to start-up to operation.

Have you had any issues come up yet with that, out of the course of the ordinary, I should say?

I would characterize it as things that you would expect to happen as you're turning over systems and processes. Dhiaa, would you add anything to that?

Yes. I mean, in any start-up, of course, you will have issues. And that's why you go through the testing. We did experience some, but I would not put it outside of the normal range that you would expect for a first-of-a-kind type of system.

Okay. My second question is, I listened to the annual meeting yesterday. And, Jim, you made a statement saying about your commitment to new nuclear. And I just -- it's a clarification question, if you don't mind. You said 5% to 10% -- you're still interested in a 5% to 10% stake of Santee Cooper's stake. Now is that 5% to 10% of the total project or just Santee Cooper's piece of it?

It's 5% to 10% of the total project.

Moving onto Ashar Khan with Visium Asset Management.

All my questions have been answered.

And Ali Agha with SunTrust has our next question.

I apologize, I got on a little late. But on Edwardsport, assuming the settlement is approved, what does that mean, if anything, for the Phase 2 hearings that were separately going on?

This settlement resolves both Phase 1 and Phase 2 issues.

Okay, okay, good. And secondly, again, I apologize, you may have done this, but on an LTM basis, what are the utility ROEs looking like for your utility portfolio?

Ali, we had a slide in the year-end package that had targeted ROEs and what I'd love to do is have Bill Currens walk you through that off-line.

Yes, I know. I recall that. I've seen that. But I'm wondering, are you -- I know it's early in the year and all that, but still -- that is still the right target?

I think that's right. As you know, third quarter is very important for the regulated business. So we'll continue to build on the progress that we've made first quarter, but on track.

Moving onto Greg Rice [ph] with Catapult [ph].

Quick question on the merger again. If, for some reason, you guys saw a material reduction in the expected benefits of the merger, would you be able to call upon the burdensome effect clause in the merger agreement? And how would it affect this? And would this allow you to avoid having to pay a break-up fee?

Greg, the merger agreement is clear on the burdensome effect provision. It's clear on MAE provisions. It's clear on the reps and warranties. And I think rather than me trying to opine with respect to how these provisions will operate, I would urge you to read them and draw your own conclusions as to what effect they would have under the scenario that you presented to us.

Your final question will come from Michael Lapides with Goldman Sachs.

Real quick, just rate case time line in the Carolinas, when do you expect to file? More importantly, do you expect to get all of Cliffside's in the rates? And what portions of Buck county and Dan River would you get as well?

Yes, so Michael, Buck was in last year's case, and we would file this year's case with the intention of picking up both Cliffside and Dan River. So kind of filing mid-year, maybe early third quarter. And with the planned in-service dates of those plants, we would be able to pick both of them up in this case.

And does that include both the capital and the expected OpEx?

Yes.

And that is all the time we have for questions today. I'd like to turn it back to Mr. Currens for any closing or additional remarks.

Great, thank you. And thank you, everyone, for joining us today for the first quarter earnings review and business update. As always, the Investor Relations team is available for any follow-up questions. Have a great day.

This does conclude our conference call for today. We'd like to thank you for your participation.